The month of August saw volatility levels rising and performance across equity fairly muted with multiple speed bumps slowing the bulls. Volatility was backed by not so encouraging macroeconomic data registering weaker than expected numbers for IIP, GDP etc. So far 2017 has been marked by a stellar performance on the indices when economic news remained not so encouraging. The latest earnings season too reflected subdued numbers driven partly by GST implementation.
Globally we saw an upsurge of political risk—led by mounting US-North Korea tensions that triggered investor nerves, boosting volatility and pushing some market returns into negative territory. However, macroeconomic data continues to be positive with stronger than expected growth numbers registering in many developed countries including the US, Japan & Europe. Japan’s domestic economy propelled growth in Q2 to levels last seen over two years ago. However, rising uncertainty on Brexit has led UK economy to slow in Q2. Globally, a couple of risks could arise in the future are in the form of central bankers across changing their loose monetary stance to slightly more hawkish. Central bank liquidity has driven price earnings ratios higher and kept interest rates low. Another risk could be the rise of geo political tensions that could rattle the markets in the short term.
From a domestic economy stand point, Incoming data continues to points towards a disruption in economic activity following the implementation of the GST. Both the manufacturing and services PMIs fell into contractionary territory in July, while no relief came from abroad as exports growth slowed in the same month. The Indian GDP slowed significantly in the first quarter of FY 2017, recording the worst result in three years. The lingering effect of demonetization combined with confusion over the GST is having a dampening effect on activity, which has slowed notably in recent times. At the ground level, we believe there is still confusion over the new taxation procedures and how to price the products. On the bright side, these policy induced headwinds should only amount to a temporary shock, and the economy should gain steam in the coming quarters. Such structural measure will boost efficiency in the economy significantly in the medium to long term. We may just have to live through the short term disruptions.
As far as equity markets are concerned, Earnings growth has again failed to keep pace with optimism. Latest earnings season saw profit growth in lower single digit with revenue numbers being more encouraging. The low growth in the first quarter has already posted a challenge for expected 15-18% earnings growth rate for FY18 that was expected by the analysts. Downgrades for FY18 numbers have already started. The earnings story does not offer too much of confidence and the markets look a little shaky as they are valued well above their long term averages. Markets seem to be taking in all the negative news in stride with ease and the only factor that is supporting the markets at these levels are domestic fund flows. Like we have mentioned before, investing by considering liquidity as a fundamental factor could turn out to be unfavourable sooner or later. Given current valuations, we believe index level performance to be modest from here on, however, bottom up stock picking strategies would continue to outperform.